U.S.-China Relations: An Affirmative Agenda, A Responsible Course

KATHRYN PILGRIM:  (Off mike) -- meeting.  We're here to have a discussion with Carla Hills and Dennis Blair.  They are the co-chairs of the recently published Council on Foreign Relations Independent Task Force Report entitled, "U.S.-China Relations: An Affirmative Agenda, a Responsible Course." 

Before we start, please turn off your Blackberrys and all other accessories.  And this is on the record.  It's being teleconferenced.   And council members across the nation and the world are participating via a secure, password-protected teleconference.

So let's start.  This excellent report will tell you that we're in the midst of an unprecedented economic expansion.  It's benefiting one-fifth of the Earth's population.  The report finds the market-driven reforms are delivering real benefits to the Chinese people.  Beijing just announced that for the four months of 2007, its trade surplus was 88 percent higher than the same period in 2006.

China is very much a part of the global economy, first or second behind the United States in attracting foreign direct investment.  China's trading relationship with the United States is a dominant factor for the United States.  It's expanding rapidly.  And China is definitely changing, often for the better.  China's students come to study at U.S. institutions.  They're exposed to new ideas, new ways of life.  Chinese young people are connected by technology.  Chinese kids blog.  The Chinese cell phone market has 400 million users, expected to grow by 250 million in the next five years.  And technology and communications have set China on a course that will not be easily reversible by any government control.

There are, however, significant worries.  Now, this report makes clear that some Americans believe that China's strategic interests are incompatible with the United States.  U.S. political support for engagement is, quote, "under strain" these days.  The report says as China's economic and military power grows, there is considerable uncertainty about its future course.  That's a quote from the report. 

And by the way, the report is here and we have copies at the door on the way out.  I was supposed to say that first.

Now, from where I sit as a journalist, China has been in the news a lot in recent days.  Not all of it's flattering.  If you listen to the news coverage of China, it appears that the American public is in a period of deep disenchantment with China.  In some quarters in the United States, job attrition is seen as a direct result of a low-wage competitor.  In recent weeks the headlines of China's violation of food safety standards have dominated coverage on China.  China is discussed in harsh terms in the U.S. Congress these days because of the trade levels.  Intellectual piracy is lamented.  Currency reform is demanded.  A strong and often critical spotlight is now pointed clearly at China.

Today we will attempt to sort through the facts and fears on China and discuss an affirmative agenda.  Our most distinguished speakers are the co-chairs of the task force, and we are very fortunate that both of them are here with us today.

First, Carla Hills.  She's chairwoman and chief executive officer of Hills & Company, an international consulting firm providing advice to U.S. businesses on investment, trade and risk asset issues abroad -- risk assessment issues abroad.  She was the U.S. trade representative from 1989 to 1993, also serves as the chair of the National Committee of U.S.-China Relations and vice chair of Inter-American Dialogue.

Dennis Blair holds the Omar Bradley Chair of Strategic Leadership with the U.S. Army War College and Dickinson College for 2007-2008; from 2003 to 2006, was the president and CEO of Institute for Defense Analysis, a federally funded research and development center; and before he retired from the Navy in 2002, he was commander in chief of the U.S. Pacific Command.  During his 34-year Navy career, he served on guided missile destroyers in the Atlantic and Pacific Fleets and commanded the Kitty Hawk battle group. 

And thank you both for being with us today.  We look forward to your insights.

And here's how we will proceed.  We'll have an opening comment from our speakers.  I'll kick off with a question for each and then we open up to the floor.

And so, Ms. Hills, I turn it over to you.

CARLA A. HILLS:  Thank you.  Thank you very much. 

Kitty Pilgrim has taken a day off to be with us, and we're grateful.  And I'm grateful to all of you for being here.

The task force was a challenge.  It took us a while.  We addressed the economic, the trade, the governance, the military and the security issues, and we had 30 experts.  So to bring us all together was a real effort. 

We noted that the 35 years of integration with China had produced some very good results.  China has lifted 400 million people out of poverty, and in those three and a half decades, they have joined international groups gravitating toward international norms.  And yet, as Kitty Pilgrim pointed out, there's unease in this country, in the population and with Congress, unease that is worried about our prosperity is going to be diminished by China's rapid growth; that our influence is going to be eroded by China's outreach; that our security is endangered by the rapid buildup of the military; and we're offended by their human rights record.

On the other side of the Pacific, the Chinese have great unease about Americans.  They think that our outreach to Central Asia is meant to cut them off from the resources that they need for continued economic development; that our military, being positioned in the region, is to encircle them; that our export controls are meant to keep them down; and that our harping about democracy is meant to foment what is the equivalent of an Orange Revolution.

We looked at these facts, and we concluded that a three-part policy of engagement, integration and to maintain our strength to keep balance was the best way in order to shape Chinese interests in a way that we could maximize a positive bilateral relationship and minimize the bilateral friction.  And we did an assessment, and we found that China had huge challenges.

The environment -- China's very polluted.  Sixteen of the world's most polluted cities are in China.  The Yellow River pours more pollution into the Pacific than any other source whatsoever.

China is aging.  It is -- as they say, it's going to be old before it gets rich.  Demographically, it's got challenges.  Its middle class is clamoring -- at the same time that they've got 400 million people still living in poverty, the middle class is clamoring for better housing, better government services, better education, better pensions.

And they've got a volatile ethnic and religious challenge of many ethnic groups in China and rampant corruption.  And we believe that our three-part policy to integrate, to engage and to maintain our strength to balance was a way to get China to move in a direction that would achieve our national interest.

So our end recommendation of this report is that the president clearly and frequently state that the United States of America wants to have a close, candid, collaborative and constructive relationship with China, and to explain to the American people the benefits that would flow from that relationship -- economically, studies show that the average American family will be a thousand dollars per year better off in 2010 by reason of our economic and trade relationship with China -- and to describe to the American people why it is this relationship is so important, that a peaceful China is one that's more likely to adopt international norms; that a prosperous China is more likely to fuel the global economy and create opportunities; and that a secure China is more likely to be able to deal with the issues that we need to deal with globally, like energy, the environment, piracy, pandemics and so forth.

And the candor comes into we should talk very candidly with the Chinese about the issues that trouble us, and there are many of them.  The trade imbalance, for example -- there are things that we should do in cutting our spending and our deficit.  There are things that they could do which would be to stimulate consumption.  On intellectual property, we should make no bones about it.  We need to have that problem corrected.

There are a number of issues, and you'll probably raise them in this report.  I don't want to take too long, but suffice it to say we think that our nation is better off if we sit at the table and talk with China in trying to solve the problems that are confronting us than by having either a stovepipe mentality that prevents us from linking issues or a hostile attitude that prevents us from solving issues.  And, Kitty, I think that's a fair summary of our position.

PILGRIM:  Let's turn to Admiral Blair for the strategic side.

DENNIS C. BLAIR:  Thank you.

In the report, we addressed five areas in our recommendation:  the economic relationship, which Carla has mentioned; the security relationship, which I'll talk about some; and then specific issues of nonproliferation; the whole cluster of political reform, rule of law, civil society issues with China; and then finally, the environmental issues, which Ambassador Hills also touched on.

On the issues of civil society, political reform in China, let me just mention a couple of things.

Number one, we thought the United States should stick by its principles that we believe, that our country is founded on, and we believe that is basically on the side of history in the future.  But in dealing with China, we thought that it is more effective to move China along that path, a path that will largely be determined by their decisions, not by ours, but by working through international organizations which enshrine some of these principles, which China has joined; by raising specific issues privately rather than using them as public bludgeons in our diplomacy; and also by a lot of non-governmental efforts.  There are many organizations that are working with the legal system in China with other non-governmental organizations, and that these are the way to help China achieve the democratic principles which it itself espouses in its official statements.  So this cluster of issues was important in our report.

But turning to the security issues, if I could summarize the approach we took, we borrowed shamelessly from Bob Scalapino the, really, dean of Asian security studies when he said what's needed is to add a "concert of power" type of thinking to the "balance of power" thinking which has previously characterized security relations in Asia.

So on the diplomatic side, we believe that involvement of China in multilateral organizations that are both in the region in China and globally are important.  These should be two-way streets.  The United States should be a part of Asian regional security organizations.  We should redouble our efforts there.  We'd like to become an observer at the Shanghai Cooperative Organization, for example, an organization working against terrorism that was founded by China and by Russia. 

In addition, we should strengthen our relationships in Asia.  Our leadership has necessarily been preoccupied with what's going on in the Middle East; sometimes our level of representation in Asia has not been what it's been in the past.  But as we do that on a bilateral basis, we should reach out and include China in those relationships.  And we cited specifically the Japanese-Chinese relationship in which the United States' relations with both countries can play a strong role.  And we think Japan-China relations ought to be better; they should not degenerate into nationalist antagonism on both sides.  Similarly, as we build our relationships with India, we should talk about the Japan -- or talk about the India-China-American relationship and not allow it to turn into, again, a balance of powers, sort of billiard ball, 18th century Bismarckian approach, but should be more of a multilateral approach which can benefit the common interests of all.

So in the diplomatic area, it was really renewed emphasis on Asia after a period of some attention elsewhere, plus a broader focus that seeks to include China.  This very much complements what China itself is doing, its peaceful development policies which were undertaken primarily for its purpose; it quite explicitly feels that it needs a period of harmony on its borders in order to do the things in society and its economy that it wants to do, should -- very much complements the approach that we think the United States should take in building this and pushing it further.

On the military side, the report shows the increases in resource spending and in the specific increases in power and capability that the People's Liberation Army has made in recent years, but it also puts them into perspective; perspective number one of what other countries have been doing in the region, and the United States, which have also been moving forward.  The United States spends roughly eight times what China does.  We have been shifting more of our weight into Asia because of our interests in the future there.  And we when we look at both of these developments we conclude in the report that there really is no chance of China becoming a peer competitor of the United States in any sense of the word for the foreseeable future, and that -- fending that off should not be the basis of any American policies.

We say that we need to keep American military strength in the Western Pacific and Asia strong.  It has underwritten the Asian security architecture for the past 50 years, and it needs to maintain its present position in space capability, in maritime capability and in air capability in order to do so; and that on that basis, we should engage China on the military side in a more effective way.

Just for starters, on the non-military side, the secretary of the Treasury takes a team of, what, eight Cabinet officers over to Beijing and meets with 14 counterparts; and on the defense side, we meet at the -- we meet three levels down in our regular dialogue.  That should be brought up.  There is a lot that the United States and China have to discuss on a military basis, and we need to do it in a more systematic and more clear-eyed way.

The standoff over -- military standoff over Taiwan, of course, fits at the center of the relationship, but that can be, I think, members of our task force thought, contained as a separate issue, and we can look at those military issues in which the United States and China should be working together -- everything from simple search-and-rescue procedures, up through peacekeeping operations, working together against terrorism, piracy.  And there have been moves in this direction in recent years, and we strongly support those and think they ought to continue.

This will develop what we see as habits of cooperation, which are important, between the United States and China, where they have not existed in the past and can provide momentum in order to deal with the important issues of nuclear developments and doctrine on both sides; and Taiwan, where there are issues of escalation and what happens next that really need to be understood on both sides.

So in summary, this idea of adding concert of power to balance of power would mean that from the United States side, which is a mature, more powerful country, it will require the ability to share power in the region in a way that benefits both countries.  And on the Chinese side, it means moving into that position as they become more powerful economically, militarily, diplomatically; to be one of the countries that helps maintain the structure that benefits all, doesn't simply exploit for unilateral purposes.

I do point out before I stop that we have several unindicted co-conspirators here in the room who are on the task force.  I spotted Mike Lampton (sic/David), I see Evan Revere, Herb Levin, "Hank" Greenberg and several others.  So if what Ambassador Hills and I say is wrong, we have plenty of people to correct it in the audience, and we thank you all for your help.

PILGRIM:  I will start with my first question, and it's for Ms. Hills.  Ms. Hills, you said that you don't worry that China becomes strong; I worry that China becomes too weak.  Now some people make a strong case that there will be an implosion in China or maybe even a period of extreme dislocation.  You've pointed out the ills in your opening remarks -- aging population, rural unrest, corruption, increasing disparity of wealth, rising expectations of the growing middle class.

So given China's size and importance in the global economy, what are the dangers of any kind of political or economic disruption in China, and how through engagement can the United States help China through its growing pains?

HILLS:  China clearly has very serious problems that it must confront.  Their leadership talks in terms of wanting peace -- a peaceful zone around it, so that it continue its economic growth.  It wants, therefore, to have a good relationship with the United States, and it wants access to resources.  The leadership's best argument for legitimacy of power is that it has enhanced the well-being, the economic well-being of the Chinese people by 10-fold over the past couple of decades, and yet people are dissatisfied in some respects.

And so if there is a lack of growth in China, we worry that upheavals that have been on the increase -- social upheavals which are counted as gatherings of 10,000 or more -- could create problems, and the leadership is worried about those problems.  So it wants to focus on the issues that we want to focus on.  It wants to deal with the environment, which is a very big problem in China not only in Beijing with its polluted air, but throughout China.  We could help with our technology; working together, our business community could make a positive difference.  You could see a teamwork there.

They have problems in governance.  China's not going to become a democracy overnight, but it wants to have better institutions.  And we could help them not only with the influx of ideas that come from NGOs here and not only with our think tanks that bring the importance of rule of law there but training of jurors.  They have too few.  Training of lawyers -- they don't have enough.  And we have members here that are doing work in China that are contributing to a better governed picture. 

There are other areas where we can make a difference and hope to keep China on the straight and narrow.  We want them to be in international organizations.  Many of Americans are very, very concerned about human rights.  We think that talking to China about human rights quietly but raising our concerns at international fora is probably a better process, because it should not be a bilateral complaint.  It should be a multilateral complaint. 

And we believe that China wants to enhance its international reputation.  It feels strongly that it has a history where it was one of the great nations of the world.  And to -- and we did take Bob Zoellick's statement of a strategic stakeholder -- we want them to be a strategic stakeholder.  And we want to help them be that, but that takes some responsibility on their part.  We can contribute more than just lecturing, and China can come along at the same way. 

If you look at what China has done positively by joining the alphabet, the international organizations, most recently the World Trade Organization, it's really made a difference in their behavior.  So that's why I say, integration is important, engagement, to tell them what we really care about.  Because they care about having a positive relationship with the United States. 

They're not going to take our brief on an issue that is of national concern to them.  But if they know that we care very much about a subject, they tend to moderate their position.  And if we know they care very much about an issue and it doesn't adversely affect our national interest, we could be more sensitive.  And that is enhanced by a greater frequency of dialogue, greater candor and greater collaboration. 

We cannot solve the energy problem without China at the table.  And China's very, very worried about where it's going to find the energy to continue the growth that continues this leadership in power.  We need to sit and talk about the various mechanisms.  Strategic reserves are one possibility, but there are many others. 

And so I do think that the United States and China have many, many convergent interests, many interests where we think alike, many interests where we cannot make progress unless we work together and then some where we're quite divergent.  But if we start building collaboration with those where we think alike or have a similar interest, I think that, and I think the task force believes, that we would make better progress on those areas where we were -- had conflicting interests. 

PILGRIM:  Thank you.  I have a question for Admiral Blair. 

China's economic growth has -- they've been able to grow their defense budget -- 2007, increase of 18 percent.  In the 2006 quadrennial review, the Pentagon concluded, China has the greatest potential to compete militarily with the United States.  You touched on this in your opening remarks, but I'd like some comments on the following. 

The secrecy of China's military buildup is really fueling anxiety in the United States, and precipitous acts such as the surprise test of the anti-satellite fuels these anxieties.  The U.S. Pacific commander, Admiral Keating, is in Beijing.  He just described the task as, quote, "the opposite of China's stated goal of peaceful rise," and he calls it a, quote, "confusing signal." 

You advocate engagement.  Would you comment on how we interact with a country whose military goals are still opaque?  And particularly I'd be interested in how you believe joint exercises would help in this process. 

BLAIR:  I think most of the development in the relationship is going on on the PLA side.  If you look at the PLA in 1990 and what it is now, it is completely turned over in virtually every way, and it is trying to redefine itself and what it means.  It certainly holds the defense of China never again being humiliated the way it was in the many wars in the last century as a high goal.  It certainly believes it has been told to get ready to coerce and if necessary unite -- reunite Taiwan by force.  It has those two missions.

But it also -- as it's growing, it realizes in the military sphere, as well as in the diplomatic sphere, that it's now considered one of the largest and most important nations in the world and has the responsibilities of sort of keeping the whole system together.  Acting responsibly at the United Nations, dealing with places like Darfur and elsewhere, where there are threats to everyone, are also laid on its plate.

So what I see when I talk to the PLA officers is them coming to grips to China's new place in the world. 

I don't think it's surprising that a number of mixed signals come out of China from -- on a fairly frequent basis.  A lot of it has to do with compartmentalization within China.  A lot of it has to do with their feeling that they've been weak for so long and the general Chinese tendency -- if you're weak, you dissemble in order to have other people think you're strong.  They've got to realize now that that kind of approach is counterproductive, because when you dissemble when you're strong, people think you're even stronger and more of a threat.  And China has to realize that now it needs to be predictable and transparent militarily in its dealings with other countries, in order not to have them assume the worst and then act on that assumption.

There are certainly PLA generals that I've talked to who want to do nothing better than to knock off the United States.  They look back to the fine old days of Korea, when they had a chance to do it, and would like to do it again.  They are not the mainstream of the PLA officer corps right now, who is, I think, more attempting to come to grips with what their country's future should be in a more mature way.  And I think we will see different signals out of China militarily.  And we -- as we say in our report, we should encourage responsible military behavior by China, but we should make allowances for other kinds of behavior, in case things take a different turn.  But our primary emphasis should be on trying to build these habits of cooperation on top of keeping a stable security structure in Asia.  And we -- that stands the best chance of things coming out well for both countries.

PILGRIM:  Joint exercises -- you could touch on that for a bit?  None are scheduled at this --

BLAIR:  Oh, the exercises.  Yeah, yeah.  The exercises are good for habits of cooperation.  I mean, one of the things I felt -- I was commander in chief, Pacific Command, when we had the EP-3 incident.  There was one Chinese pilot in the water.  We were that far from having 23 American sailors in the water at the same time.  We had ships that were about -- were less than a hundred miles away in the South China Sea.  China, of course, had bases that were 70 miles away.  Had we responded together, we had no way of talking to each other -- radio frequencies, search patterns and the normal things that you do when airmen or mariners are in trouble at sea.  So at the most basic level, the exercises help you do what's right for your people.

Then you need to exercise on the things that you'll be likely to do together:  operating against pirates, being together in peacekeeping forces around the world, operating against illegal immigrants.  And if you can work your way through those, then you can have a really mature military-to-military relationship. 

I'd say we're on the bottom rung of that now.  I favor moving up those rungs.  And at the same time as you're doing the actual exercise, you have to have the staff talks that work out the procedures for them.  Those in themselves tend to build a -- build relationships that strip away some of the mystery on both sides, which is, I think, good in this relationship.

PILGRIM:  All right.  We would like to invite members to pose their own questions.  And wait for the microphone.

Sir?

QUESTIONER:  Admiral Blair --

PILGRIM:  Would you state your name and affiliation? 

QUESTIONER:  Yeah, yeah.  Chen Men (ph) from the World Journal, a local newspaper.  Yeah, Chinese.  You have saying that -- separate Taiwan from all the other issue(s), but it's very hard to do.  And you understand that the Taiwanese is not very happy with the Americans forcing them to buy American armaments.  (Chuckles.)  And your government has been very -- pushing very hard for the Taiwanese to defend itself, but the Taiwanese are not eager to defend itself, but they want independence. 

So how can you square the circle and (help ?) Americans' true interests in Taiwan as a -- (front ?) client state to contain China?  It's both in Chinese thought and in Taiwan's deep blue thought that America will never abandon Taiwan, to be as a guardian as a first chain of island defense.

BLAIR:  That's about a two-hour discussion that you just -- that you open.  (Laughter.)  And I disagree with about four of the things that you said.  I'm trying to think how an answer could be productive.

I think from the -- I'm basically concerned about American policy.  And I think that the Taiwan Relations Act, which has been passed by our Congress, signed by the president, and followed by every administration since, is really the solid foundation for American policy in the region.  And I also happen to believe that that policy is good for both Taiwan and China.  That says that any change in that relationship between Taiwan and China should be peaceful; that the United States will ensure that the military balance in that part of the world is conducive to a peaceful solution, that neither one side nor the other is tempted to use military force in order to advance its political position, but that military -- use of military force is not a tool by either side.  And that eventually, there would be an arrangement between Taiwan and China based on the principles we've all accepted.  And I think that's the way we have to proceed.

PILGRIM:  Questions? 

Sir.

QUESTIONER:  Nicholas Brandt (sp) with Lazard.  History teaches us that with the passage of time, and as educational and living standards raise, people start becoming interested in democracy.  And in your list of problems I don't think -- I was intrigued that you didn't talk about the challenge that China faces as it faces increasing demands from its people for greater political freedom.  I wonder if you could expand on that a little bit for us.

HILLS:  If you took a poll in China today and asked the Chinese:  Do you want democracy? -- I think they want personal and economic security.  What they want is a responsive government.  You have a problem in the rural areas because the land values, under the communist system, do not belong to the people.  And you have a perverse incentive for the local leaders to develop the land, to develop the money to run the rural areas.  And because the Communist Party controls ultimately the courts, there is no safety valve.  So that is a source of contention. 

But the people really want a more responsive government.  They are not certain on the polls that they want, quote, "a democratic government."  And we think that we can help by talking to the Chinese about these perverse incentives.  You know, if there is a great social upheaval in China and there is an implosion, the whole world suffers.  If we thought the Asian crisis in '97 was a strain on the global economy, for China to have an implosion would create an enormous trauma for the global economy. 

So we think that the Chinese leadership wants to move toward more responsive government -- they use the word "democracy" -- but at the right time.  And in the urban area, you have a dissatisfaction with the middle class.  We're finding that they have no way to go -- nowhere to go to get their dissatisfactions addressed.  Talking to China, again, about court systems, mediation, arbitrations, mechanisms outside the political regime, which would be in their interest to keep stability and continued growth; in our interest because it's compatible with our values, and will keep China, we think, moving in the right direction. 

The report talks about these things, and it requires a greater factual understanding of the challenges facing China and a greater willingness to try to figure out how bilaterally and plurilaterally we could develop mechanisms to help China deal with the challenges that it has identified that it must deal with.

PILGRIM:  Questions.  Mr. Sorensen.

QUESTIONER:  Admiral, aside from the special case of Taiwan, is there any country in Asia that has legitimate fears of the Chinese military?  And if so, do they have expectations of U.S. support?

BLAIR:  If you look at what China has done over the last 15 years, it's been really marching around its borders settling long-standing border disputes, which have been there for a long time. The process has been just about completed, has been completed with Russia, just about completed with Vietnam.  The major outstanding border dispute is with India, that area beyond the Himalayas.  And that is really the one neighbor that China has not sort of sorted out where the border lies.  Certainly from the Chinese side and on the Indian side, there's a general expectation and approach that that will be done peacefully.  So I don't detect a lot of short-term concern by China's neighbors that tanks are lined up on the border ready to roll into new areas. 

I think what there is among China's neighbors is sort of a long-time, more distant fear that as it becomes more powerful and more military powerful, it will have the means to be able to dictate things, either in soft power or in hard power terms, just because of the weight of its economic and military power.  And they're looking quite closely at China's development to see if China goes that way or if it turns out to be a powerful and relatively cooperative and benevolent people.

I've said publicly before that how that goes is really in China's hands.  If they do turn their increased economic and military power into coercive and aggressive powers in places other than Taiwan, where their rationale is fairly well understood, then I think they are going to find a net drawing about them of their own making.  If they exercise it in a way that respects other countries and doesn't pose a threat to them, then they will have a very cooperative set of neighbors.  So it's really up to -- I think it's really up to China, and I think the early signs are, frankly, encouraging.

PILGRIM:  Question?  Sir.

QUESTIONER:  Thank you both.  Thank you, all three.  I'm James Tunkey with I-OnAsia.  China's had really four regimes since the revolution in the 1940s.  We've had more than double the number of presidents and 10 times as many Congresses.  That makes it very difficult for Americans to communicate with the Chinese.  Is there an institutional change that you would recommend that would make that communication easier and for Americans to have a more long-term relationship-focused dialogue with China?  Thank you.

HILLS:  You're right, the subject of China is a complex subject.  It is rich; it's poor.  It's urban; it's rural.  It developed some on the coast and it's pathetically underdeveloped in the inner areas.  And so it's hard for the American public and their elected representatives to immediately grasp how to deal with China. 

Looking back, although we have followed a policy of engagement, we will talk, the first couple of years of every new administration, Republican or Democrat, have been a little bit rocky.  And our perception is that the relationship from the viewpoint of many of our elected representatives in Congress is quite rocky.  Our perception is further that the level of information about China is deficient.  Indeed, two respected members of the House of Representatives, Congressman Kirk and Congressman Larsen, who went to China under the auspices of the National Committee on U.S.-China Relations, bonded and came home and created a study group.  But in doing so their comment was, Congress is woefully ignorant about China.  And these are people of the place. 

So what is the fix?  One fix is that they would just read the report.  (Laughter.)  We need to get some facts up there, just basic, basic facts.  And then we need to start to work together, because hostility based upon ignorance is the most foolish kind of hostility that one can conceive.

So we do believe that taking up -- trying to understand the issue and then trying to work it out -- that doesn't say that we will agree with China.  We have massive disagreements with China, but we ought to understand the facts.

Their currency issue is a hot issue in Congress, and we want them to revalue their currency.  And this is a complex issue.  There's no easy answer.  If they were immediately to cause an appreciation of the yuan by, say, 30 percent, we would have unintended consequences in this country -- interest rates would go up, inflation would be affected.  They would have what they (predict ?) consequences in their country.  Their rural population would suffer as food prices would increase; their urban population would suffer -- and there's a great jobless population in both sectors, because exports would decrease; and they'd worry about the upheaval.

So how do we have a soft landing on this issue?  We recommended in the report that we broaden the discussion.  No currency fix will work unless the East Asian currencies are revalued.  Japan is out of step.  It is undervalued.  The yuan is out of step; it's undervalued.  But I could conceive of a group of Finance ministers sitting down and working out, what are we going to do going forward?  And that would be a constructive way to address an issue that is creating enormous hostility and lots of complaints being thrown back and forth across the Pacific based upon ignorance.

PILGRIM:  Sir.

QUESTIONER:  Bob Belfer with Belfer Management.  I would like to raise the question of North Korea, which seems to have gotten very scant attention.  As we know, North Korea, for the second time, has agreed to take a whole series of actions to give the world comfort concerning their nuclear program and to also recognize that China, by way of applying both food and energy to North Korea, is in the strongest position to influence their policy.  It seems that in the latest round that the Chinese have been conspicuously quiet.  Would you care to comment as to what it is that we can and should expect of China?

BLAIR:  I think that the U.S. and Chinese positions on North Korea have been coming together in recent years.  When I would talk to the Chinese about North Korea six years ago, their attitude was that the United States was way overblowing the Korean threat, Korea didn't have any nuclear weapons, and if they had, wouldn't use them.  And I think that has changed to the point that China privately warned North Korea not to explode a nuclear device; it did, against China's advice, and I think that China now realizes that North Korea is on the wrong side on this thing and it's posing a danger to the region.  I don't think they feel the danger quite as closely as we in the United States do, but nonetheless, they've come along.

I think the missing thing in China's calculation is -- right now is, okay, if we put maximum pressure on North Korea with the other countries in the region, what would happen after that?  Would the country come apart?  How would it come apart?  Where would the nuclear weapons go?  China certainly doesn't want to have a unified Korea with large numbers of U.S. troops stationed there with nuclear weapons.  If that's where this thing went, they're happier where they are.

So I think the next stage of the dialogue between the United States and China and the other three countries involved is, okay, we kind of agree that we don't like North Korea as it is; these nuclear weapons are a threat, they're not just toys, they can do a lot of damage; so where we do steer North Korea and how, therefore, do we use the carrots and the sticks that all of us have?  And as you -- I agree with you very much, that China has most of the sticks; sticks are not always decisive.  You can't always get someone where you want to with just sticks.  There have to be some carrots, there have to be some other shaping things.  But I think the trend in Sino-American understanding of where North Korea is has been excellent, and now we need to reach, where do we want to go with Korea?  So I think the trend is good.

I think I differ from many others in that I think time is on the side of -- is not on the side of North Korea in this thing.  I think things are closing around them.  They're increasingly isolated.  They are going to have to make changes here, and I think we're headed in the right direction, although it's excruciating, I agree.  (Laughter.)

PILGRIM:  Sir?

QUESTIONER:  I'm Allen Hyman from Columbia-Presbyterian.  Next year, the eyes of the world will be on China as China hosts the Olympics.  To what extent do you think China will be particularly sensitive to world opinion, because it is the host?  And I'm specifically interested in Darfur and Sudan.

HILLS:  I think that the 2008 Olympics are the coming-out party for China, that it wants the world to see it in the best light possible.  I think you will find that it shuts down its factories so the air is cleaner -- (soft laughter) -- that it will do everything in its power to make this a positive view.

As I said at the beginning on issues like the Sudan, where we diverge, this is an issue where I think we have an opportunity with China.  China wants to be respected, I think by -- and in fact, in recent months it's moderated its behavior.  We do see a difference.  When China understands how keenly we and the international community feel about a particular issue, unless there's a direct collision with something that is of their vital interest, they try to accommodate.  And you can only know that by talking and by bringing China into international organizations.

So when we engage -- we share with them the depth of our feeling on an issue like Sudan, we don't want them to be providing aid and assistance to a government where we're trying to shape its behavior by reason of aid, with the tools of aid and assistance.  And so I think that it's not only that the Olympics is making China more focused on the international stage, but I think that this engagement and then integration into the multilateral and plurilateral organizations that deal with issues so that they can vote, that we stop saying, do what we say because it's the right thing to do, and have them vote on with us as an equal.  So these kinds of strategies, we think, will produce a better harvest from the U.S. national interest than a more cantankerous strategy.

BLAIR:  I find when you talk with the Chinese on most subjects, they are very practical.  And the United States has a very rich history of providing aid to countries which we didn't much like the regimes of during the Cold War, and the results were not always to our advantage in the long term, and I think we see some early signs of that with China, some of the resentment in Africa and other places against this sort of, you know, hands-off, give the project to the government kind of an approach that they're taking on this resource extraction project.  So I think from a practical point of view, the Chinese are going to find what the United States has learned, is that economic development in countries that are underdeveloped and have all sorts of government and ethnic, violent issues has to be done with a great deal more care than China has shown in recent years.

PILGRIM:  Sir?

QUESTIONER:  I'm Hunter Smith (sp) with Bumbi (ph).  In a recent speech, Wen Jia-bao characterized the fundamental -- the underpinnings of China's economic growth as unsustainable, and one aspect of that, which he indicated and which other analysts have cited, was the rampant growth of commercial lending, particularly to fund construction of fixed assets.  And the analysts have pointed to the fact that control of commercial credit generally lies more in the hands of local and regional communist parties than with banking officials.

Is there any way for China to resolve this institutional conflict to create more sound credit growth?

HILLS:  Without a question, there are things that China can do.  It is spending about 43 percent -- 43 percent of its growth comes from investment.  That's extraordinarily high for a developing country.  And so it would be much better if instead of having the state fund new investment -- like steal plants and industrial facilities and real estate development -- if they would allocate those resources in the same percentage to consumption, which would also feed their economic growth.  And two areas where they desperately need to stimulate consumption are in the health and pension field.  If -- and they would moderate the possibility of upheavals if people were less anxious about their future.

The other thing about China's economy is that it has a 50 percent savings rate, rather extraordinary to this country when our private savings rate is in the minus column, but 50 percent is incredibly high vis-a-vis any developing country.  The reason it's so high is precautionary savings.  They're saving for their health; they're saving for their old age.  And with a One-child Policy, they don't have much human insurance.  So if the government would allocate monies to stimulate consumption that would create growth, alleviate the need for precautionary savings, we would get a better balance between our two economies.

The other thing they could do, which you would probably like, would be to open up the consumer credit market.  You know, they don't have credit cards to the extent that other countries do or cannot buy houses with mortgages.  If they would open up and let financial services into their economy that could lead by example -- other countries have done that with great benefit.  And the -- I always think of the mortgage market, the consumer credit market and the insurance market are absolutely home runs from the point of view of the Chinese people, and the competing banks are not adversely affected because by seeing the good competitive practices, they become better.  We've seen that in other countries; we've also seen it in China.

There a number of things that China could do to fix their imbalance, and we could talk to them about those but also talk about what we must do, which is to cut our deficit.  And that means that we have something to talk about that has a positive outcome for the tremendous imbalance that is affecting global economics.

PILGRIM:  Sir?

QUESTIONER:  Robert Flint, Dow Jones Newswires.  The U.S. policy on China seems very much to be good cop-bad cop with the Senate and House of Representatives playing the bad cop, threatening punitive measures against China; and the administration and Secretary Paulson taking a much more conciliatory approach.

Do the bad cops have a role to play in this in convincing China that the U.S. means what it says, or are they only disrupting things for the good cops?  (Laughter.)

HILLS:  Is this on the record?  (Laughter, laughs.)

BLAIR:  Madame Ambassador, as the practiced bad cop in some past lives, I think that's your question.  (Laughter.)

HILLS:  (Laughs.)

BLAIR:  I do my bad cop in other areas.  (Laughter.)

HILLS:  It's good to be firm.  It's not good to be wrong.  I think that it would be helpful to have the Congress articulate its concerns about imbalances, currencies, but it ought to get its facts straight.  And it would be helpful to have it work with the administration.

I think that our secretary of Treasury has done a terrific job with China and with engagement, and I think his strategic economic dialogue is long overdue.  And so I think he's entitled to enormous applause.

Why did he do it?  Because he understands China and that shows through.  I think that it's one thing to have a good cop-bad cop in a negotiation when it's a question on a spectrum where you're both standing on good facts to say it won't sell unless we get more.  But it's irrational, some of the things that are being suggested in legislation that has been proposed. 

And you take the 27-and-a-half percent tax that the senior senator from New York is proposing.  Let's just suppose that was imposed, and let's suppose we put a 30 percent, 100 percent tax on everything that came in from China.  That really would not fix our trade deficit.  Because 65 percent of what we import from China is the production of other East Asian investors in China -- Japan, South Korea, Taiwan, Singapore, et cetera.  And they would simply withdraw either back home or to Cambodia, Laos or Vietnam. 

So Americans would continue to buy the products that they're producing in China at a slightly probably higher price, which would be a tax on the lower income population.  But our trade deficit wouldn't change.  And I'll point out the fact that if you go to 1990, our trade deficit with East Asia was just slightly higher than our trade deficit today.  The difference is that it is down with Japan, down with Taiwan, down with Singapore but up with China.  And so what we need to do is to work on these issues of currency, open markets and trade balances together and collaboratively, talking candidly about our political limitations.  And by the way, China has a few political limitations, too, but I think we could come to a constructive outcome. 

BLAIR:  I think though that your question gets at one thing that we talked about quite a bit in the task force, which is that the benefits of the economic relationship with China are fairly widely spread; the pain is very narrowly felt.  And so to try to take advantage of the availability of more cheaper products, the overall benefit to families, while still dealing with those individual sectors within the United States which are penalized before it, is the real challenge. 

PILGRIM:  A very good note on which to end this discussion, and we'd like to thank on behalf of the council Carla Hills and Admiral Blair.  Thank you.  (Applause.) 

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